Financial Regulation Reform at Critical Juncture in Senate

The president is expected to again push major regulation reform, including a new Consumer Financial Protection Agency, in his State of the Union address Wednesday night.

But the initiative remains stuck in the Senate Banking Committee, where the top Republican, Sen. Richard Shelby, (R-AL), has been negotiating with Chairman Christopher Dodd, (D-CT), over a possible bipartisan compromise on legislation. Financial industry sources say one of the main sticking points is the CPFA—and a showdown is coming.

In an interview with FOX Business, Shelby said that while he hopes committee Republicans and Democrats can reach a deal on reform, “we don’t have to have a bill.”

He said he remains “vehemently opposed” to creating a CFPA and “we’ll soon find out” if Democrats are willing to compromises on it and other issues to proceed with legislation.

Shelby would not discuss details of the negotiations. But two financial industry sources said he recently gave Dodd a list of provisions that committee Republicans and Democrats could likely agree on—and provisions Republicans will not accept, including a CFPA.

As recently as Friday, the President pounded the rhetorical table for a CFPA, which he has made the cornerstone of his reform push. He and consumer advocates say it is necessary to regulate the sales, structure and marketing of mortgages, credit cards and other consumer financial products--especially to halt predatory sales practices in the industry.

“So long as I'm president, I won't stop fighting to protect you from the kinds of deceptive practices we've seen from some in the financial sector,” he said in a speech in Ohio. “That's why I'm fighting for a tough consumer financial protection agency, to protect you against those hidden overdraft fees that can make a single ATM withdrawal cost 30 bucks.”

But Shelby and the banking industry say a CFPA would add an unnecessary layer of regulatory oversight and bureaucracy for firms that would raise costs to consumers and limit innovation in financial products. Among possible compromises on the issue, sources said: beef up consumer protection in existing agencies or create a new consumer protection office in the Treasury Department.

As part of ongoing business outreach efforts, the President and members of his economic team had lunch at the White House Tuesday with six corporate CEOs, including Jamie Dimon of JPMorganChase (JPM) and Ed Rust of State Farm Insurance.

According to a financial industry source with knowledge of the meeting, the President told the executives he has expended a lot of political capital on financial regulation reform and he again raised concerns about bonuses at financial firms.

Bonuses are a populist hot button that the President is also likely to discuss Wednesday night, as he pushes fresh proposals to constrain the size and riskier activities of financial firms and promotes a new bank tax to raise at least $90 billion to repay projected taxpayer losses in the government’s TARP bailout program. The tax would be levied on the top 50 financial firms, including those that have repaid TARP funds.

A White House spokesperson was seeking comment from officials on the meeting.

As with health care, the upset victory of Republican Scott Brown in the Massachusetts Senate race last week strengthened Republican leverage in the negotiations on financial reform, though Shelby downplayed the significance of Brown’s win. Under Senate filibuster rules, it takes 60 votes to defeat a filibuster. With Brown’s victory, Democrats will have just 59, to the Republicans’ 41, enough to block any legislation.

“It give us another vote and I guess you could infer leverage there,” Shelby said. “We do have 41 votes – 41’s a lot better than 40.”

But one financial industry lobbyist, who asked not to be identified because he has current dealings with the banking committee, said Brown’s win “greatly decreases the probability of a bill…the momentum has slowed dramatically.”

Proponents of ambitious financial reform, including a CFPA, argue lawmakers cannot face voters in the Congressional mid-term elections in November without completing work on a bill. But the lobbyist said Senate Republicans are prepared to argue that they tried to reasonably compromise with Democrats and that the initiative failed despite Democratic control of both houses of Congress and the White House.

Another industry official, who also asked not to be identified because he has current dealings with the committee, said, “The problem is that if Obama makes the CFPA the litmus test--then there is no bipartisan chance and no bill. There is no appetite among the moderate Democrats, after health care and MA (Brown’s victory in Massachusetts) for a big fight on the CFPA, and the Republicans are highly unlikely to budge. I think the Republicans are quite willing to work on a bill but are not willing to give on the CFPA to get one. Dodd would certainly like a bill.”

Last month, Dodd announced he will retire from the Senate at the end of his term. He faced a declining poll numbers and voter anger in his home state of Connecticut over his ties to the financial services industry.

Also dimming prospects for a major overhaul – new national polls showing voters more concerned about jobs and the overall economy. In a poll released Tuesday by the Pew Research Center, 33% of voters said the President is paying “too much attention to the concerns of banks and financial institutions, the highest percentage for ‘too much attention’ for any group asked about,” the Center said.

Shelby said other concerns for Republicans in financial reform include derivatives trading – “a very complicated area”—and how to tackle failing companies that are “too big to fail” and could require future taxpayer bailouts.

On the latter, Dodd and the White House have proposed granting regulators new powers to take over and wind down a failing firm before it can damage the financial system. But Shelby said he instead favors establishing a new type of bankruptcy court to handle such firms.

Finding compromise on these and other issues, Shelby said, “depends on how we continue to work together and whether or not Democrats want to go it alone. I hope they want to work with us in a bipartisan fashion…I hope they will…We have made some progress but we have not crystallized the language of the bill.”

But he added, “There’s always a possibility of getting nothing up here because to move a bill of this complexity, we’re going to have the have bipartisan agreement. We’re working toward that end now, but we are not there yet.”

“Our view is that the loss of the filibuster-proof majority will not derail financial reform because Democratic leaders were always going to need Republicans to pass the measure,” he said in a note to clients last week. “To us, the issue is whether Democrats will decide it is in their interests to enact a bill or to force Republicans to kill the measure. This has always been the calculation. What is different today is that the Massachusetts election suggests the prior Democratic strategy did not work.”

Seiberg said he believes Senate Democrats “ultimately will decide it is better to compromise and get a bill than to hold fast” in part because “achievements matter in politics when you are in charge” and Dodd “really wants a bill as the capstone of his congressional career.”

Shelby said the President’s new proposals to tax banks and limit their growth and riskier activities will slow the legislative process, in part because they will require additional hearings.

“He’s raising the ante up,” Shelby said. “We ought to flesh it out.” The banking committee announced Tuesday it will hold its first hearing on the proposals next week.

But Shelby went on to criticize them.

“I’m not a tax man,” he said. “I don’t think taking money from banks that have already paid their TARP money back…makes sense.”

The House passed its 1,300 page financial regulation reform bill, which includes a CFPA, late last year with no Republican votes. Any Senate legislation would have to be reconciled in a conference committee with the House.

In a briefing with reporters Tuesday, House Democratic Leader Steny Hoyer (D-MD) said, “We’ve acted. We look forward to working with the Senate.”